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M&A Insurance Picking Up Steam As Policy Prices Sink

Deal makers are more interested than ever in insurance that protects them from representation and warranties risks as coverage prices drop and they become more familiar with the policies, and experts expect this momentum to last if underwriters can keep up as claims start rolling in.

The popularity of such policies has skyrocketed over the past three years, especially among private equity firms, spurring an influx of interest in the marketplace and a wider field of competitors that has driven down prices. But it's up to lawyers and underwriters to carve out a permanent place for the coverage with streamlined implementation and pain-free claims processing, attorneys say.

"People have gotten more comfortable with the idea," said Gabor Garai, who chairs the private equity and venture capital practice at Foley & Lardner LLP. "But it's still not a standard form of policy. There's still a ways to go before it becomes totally standard."

Reps and warranties coverage protects buyers or sellers from losses incurred post-closing, tied to a seller's false representations and warranties. The policies can cover financial statements, litigation and tax information, among other things. They also free sellers from locking up a portion of a deal's proceeds in escrow to cover future claims, promising quicker and bigger payouts.

Aside from the instant gratification for sellers, the coverage has also wooed buyers by promising an extended period for claims recovery. The standard term generally lasts between 12 and 18 months, but the insurance commonly extends that span to three years or longer, giving buyers more flexibility.

But as the coverage takes hold in the marketplace, the policies' underwriters — relatively new to the M&A world — step into focus as the policies become more prevalent, and as first-of-their-kind claims continue to trickle in.

"That whole dynamic of dealing with insurance companies versus [sellers] is going to be an interesting aspect of how this phenomenon of insurance for reps and warranties will evolve," Garai said.

Kirkland & Ellis LLP corporate partner Jeremy Liss, who focuses on private equity, earlier this year spent months working on a claim. Liss worked alongside David De Berry, who heads up Concord Specialty Risk, a subsidiary of Ryan Specialty Group LLC that underwrites reps and warranties policies on behalf of insurance companies.

After conducting an investigation into alleged misrepresentations at a manufacturing plant involved in a sale, the two worked to calculate what De Berry called "significant" damages and deliver on the claim. Both conceded that the process was a lengthy one — De Berry gave himself a B-plus in terms of turnaround time — but said that moving forward, they expect to cultivate a more streamlined approach.

In traditional M&A transactions, reps and warranties negotiations can be slowed down by two unfamiliar parties getting to know each other for the first time, often without a shared sense of direction, Liss said. But if lawyers are working consistently with underwriters on these policies, over time they will naturally streamline procedures.

"You've got a policy you have negotiated [before], which can be a baseline for future deals," he said. "You know where you're going to end up; you know how much time it's going to take to get there."

But even with a well-oiled relationship between an attorney and underwriter, there could be other barriers to growth. Garai pointed to the insurance industry's reputation for red tape and runarounds as a potential deterrent to deal makers who are used to drawing up sale agreements the traditional way.

He also highlighted an upfront underwriting fee that generally hovers between $10,000 and $25,000, payable before an insurer even decides whether it will take on a policy. The cost can be too high, depending on deal size and the amount of risk sellers perceive they face in the first place.

Despite the challenges, the widespread consensus is that reps and warranties insurance has room to grow if attorneys and policy providers play it right, though the coverage has a natural ceiling on its demand.

Factors unique to each deal, in addition to a seller's position in the marketplace, can play into whether coverage makes sense. For example, a private equity firm that is not under pressure to show hefty returns to raise funds immediately would be more likely to opt to shoulder its own risk and leave a portion of its sale's proceeds in escrow for a longer term.

But even while some transactions fall outside the sweet spot for reps and warranties insurance, Kirkland corporate partner Hamed Meshki said, clients are asking about it increasingly often — a telling sign that the coverage is cementing its place in the deal-making world.

And that will likely become more true over time, he said, noting that insurance providers have yet to reach an ever-shrinking, but still sizable, chunk of the marketplace.

"It's not always the right answer in every transaction — sometimes you consider it and decide that it's not right for your transaction to pursue a reps and warranty policy, but it's something that is worth considering at some point in almost all M&A transactions," Meshki said.

In some markets overseas, reps and warranties insurance has recently become more of an expectation among deal makers. The shift is thanks in part to local M&A rules that have fostered a smoother integration of the policies into everyday M&A activity.

In Australia, about 90 percent of transactions are covered by a reps and warranties policy, De Berry said. Across the Atlantic, about 60 percent of European deals sign on for coverage, with a specific focus on transactions in the U.K. — still far outpacing U.S. deals, he said.

But given stateside chatter over the insurance, De Berry said he expects to see sustained growth as the U.S. market for reps and warranties takes on a more defined shape.

"We lag behind those markets in a huge way," he said. "This is developing momentum and it looks very much like we're on the precipice of real growth."